Consideration for the use of IPRs includes occasional onsite support. Such visitors perform stewardship activities and do not give rise to service PE.
Employees of parent company visiting the premises of an Indian Company for quality inspection to ensure that the licensed products meet the global quality standards perform stewardship activities and do not trigger service PE. Performance of technical services by employees on behalf of the Taxpayer results in a Service PE for the Taxpayer as per India-UK DTAA.
Effective connection is to be seen between the PE and the “contract, right or property” from which royalty or FTS arise.
Facts:
The Taxpayer, a UK company, was engaged in the business of manufacture, assembly, research, design and sale of material-handling equipment. The Taxpayer entered into a Technology Transfer Agreement (TTA) with its wholly-owned Indian subsidiary (ICo).
As per the terms of the TTA, the Taxpayer was required to perform the following activities for a consideration:
• Grant license to manufacture, permit the ICo to use know-how, trademark, inventions and any confidential information (IPRs) belonging to the Taxpayer.
• Provide technical assistance to the ICo’s personnel through its technical consultants to enable the licensed products to be manufactured as per the quality standards.
• Conduct random testing and inspection of licensed products manufactured by the ICo to ascertain if they meet the quality standards. For this purpose, employees of the Taxpayer occasionally visited the premises of the ICo.
For the technical assistance as stated under the TTA, the Taxpayer deputed eight employees to work with the ICo. The cost of such employees was recovered from the ICo. Such personnel occupied key managerial positions and were engaged in managing overall operations of the ICo.
The Tax Authority contended that the employees deputed for more than 90 days constituted a Service PE and the payments from the ICO being effectively connected to the PE need to be considered as business profits under the DTAA.
However, the Taxpayer contended that it did not have a PE in India as:
• Occasional visits of the Taxpayer’s employees for inspection and quality check were an integral part of royalty. Hence, the entire consideration for IPR under the TTA (embedded with the cost of occasional visit of employees) was taxable as royalty/fees for technical services (FTS) under Article 13 of the DTAA, as well as ITA.
• Personnel deputed under the IPAA ceased to be employees of the Taxpayer and they became the employees of the ICo. Accordingly, the presence of such personnel did not constitute a PE of the Taxpayer in India and reimbursement of salary of such employees under the IPAA was not taxable in India.
On appeal, the CIT(A) upheld the position adopted by the Taxpayer. Aggrieved, the Tax Authority filed an appeal with the Tribunal.
Held:
On constitution of Service PE
Based on the facts, the following factors supported the view that the assignees continued to be the employees of the Taxpayer:
• Assignment of employees to the ICo was pursuant to the license of IPRs to the ICo, for which, the Taxpayer committed to provide technical assistance to the ICo from time to time at the ICo’s request and subject to the availability of specialists or engineers.
• No employment contract between the ICo and the Assignees/appointment letter/terms and conditions of deputation were placed on record before the Tribunal.
• Assignees retained lien on their employment with the Taxpayer such that, after completion of assignment, the Assignees would resume employment with the Taxpayer at a level no less favourable than that which they left prior to the deputation.
• Agreements clearly mentioned that the Assignees would be subject to the rules and regulations of the ICo but would not be considered as employees of the ICo.
• The Taxpayer had full responsibility to remunerate the Assignees. Recovery of cost from the ICo is nothing but consideration for supply of the Assignees.
• The Assignees have no legal recourse to the ICo for any grievances or disciplinary actions.
It is quite natural that persons deputed with the ICo for a consideration will work under the direction of the ICo and could not have worked for the benefit of the Taxpayer. Since all the conditions of Service PE were satisfied, it was held that Taxpayer constituted a Service PE on account of assignees.
On account of service integral to a royalty arrangement under the TTA, the Tribunal held that occasional visitors undertook activities in India in terms of the obligation integral to the TTA i.e., testing and inspections, which were carried out to ensure that the licensed products adhered to the global standards of quality. Such activities were required by and in the interest of the Taxpayer and it amounted to stewardship activities which cannot be considered for constituting a PE in India. Reliance in this regard was placed on the SC decision in the case of Morgan Stanley (supra).
On Taxability under Article 7 on business profits visà- vis Article 13 on royalty and FTS
Consideration for granting the IPRs in relation to the technical know-how, patent rights and confidential information for the manufacture and sale of licensed products falls within the scope of royalty as defined under the DTAA, as well as the ITA.
Consideration received for the provision of services of personnel was for the application/enjoyment of IPRs and it qualified as FTS under the DTAA, as well as the ITA.
Effectively connected with PE
In terms of the DTAA, where a right or property or contract for which the royalty or FTS is paid is effectively connected with a PE through which the beneficial owner of the income carries on business in the source state, (i.e., India in the present case), then such royalty/FTS would be taxed as “business profits” under Article 7 and Article 13 on royalty and FTS would cease to apply.
For applicability of Article 7, effective connection should exist between the PE on the one hand and right, property or contract on the other, and not royalties or FTS flowing from such right, property or contract.
The words “effectively connected” are akin to “really connected”. In the context of royalties, it is in the nature of something more than the mere possession of the property or right by the PE but equal to or a little less than the legal ownership of such property or right. But, in no case, remote connection between the PE and property or right can be categorised as effectively connected.
It is of significance to note that an effective connection is required to be seen between the PE and the “contract” from which such fees resulted and not such FTS per se. The mere fact that such fee is effectively connected with the PE is not sufficient to bring the amount within the purview of business profits.
Taxation of various streams
For the different set of considerations, it was concluded:
• For royalty income from IPRs embedded with the salary of Occasional Visitors:
Royalty income cannot be said to be effectively connected with Service PE and the same would be taxable as Royalty on gross basis under the DTAA, as well as the ITA..
• For Service PE:
Service PE is represented by the Assignees deputed to the ICo. Thus, the contract, by virtue of which the Assignees were sent to India, is effectively connected with the Service PE and FTS arising out of such contract would be taxable as business profits under Article 7 of the DTAA.
